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Policy Briefs On-Lending in Indonesia: Past Performance and Future Prospects1 No. 1 - 2007

Experience with On-Lending Government and aid agencies have been involved in on-lending to sub-national governments and enterprises in Indonesia for over thirty years. The World Bank and Asian Development Bank have been the most noteworthy foreign participants. Most onlending has gone to water enterprises, and a large portion of funds has been concentrated in Java-Bali. The experience of on-lending has been rather disappointing. Project development and finance have at least occasionally been supplydriven. Associated loan approval processes have proved cumbersome and time consuming. The amount of finance channelled through the system since 1975 has been rather insignificant; and on-lending has declined to near zero since decentralization began in 2001. Lenders have paid insufficient attention to credit risk in finance allocation decisions. Overall, loan repayment has been weak; nearly 50 percent of payments due are in arrears.

Differences in loan performance across sources of funds appear to be mostly a function of lenders’ selection of borrowers. The investigation in this paper shows that World Bank has focused a relatively larger share of its finance on borrowers that repay comparatively well, although it must be admitted that this was probably not done in a deliberate attempt to improve loan performance, per se. The overall conclusion must be that lenders, in general and without exception, have not allocated infrastructure finance as a function of borrower creditworthiness to a satisfactory extent, nor have they paid sufficiently close attention to the collection of loan repayments.

On-Lending Regulatory Framework and Alternative Policy Directions The government has recently put in place a new regulatory framework for on-lending, but it does not appear that this will be of much assistance in facilitating improved financing outcomes.


Policy Briefs

The new project development process retains some worrying vestiges of central command and control, which may lead to locally unwelcome projects and loans. Loan approval processes are likely to remain burdensome and, as such, will create further disincentives for sub-nationals to borrow from or via the central government and, in any case, will cause delays in project implementation. The new system binds onlending to revenue generating projects, thereby unnecessarily limiting the scope and volume of lending. While the framework forces lenders to pay more attention to credit risk by insisting that they lend only to those sub-national entities without arrears on past loans, the government is doing little to increase the number of such creditworthy borrowers or stimulate local demand for credit more generally. Finally, although the government has at its disposal a simple mechanism to encourage better repayment of loans, it has so far proved unwilling to employ this tool. As a result, loan performance will likely remain problematic. It is hard to escape the conclusion that the near-term future of onlending is gloomy indeed.

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Actually, the collapse of on-lending might well constitute a positive development. At least this would be the case if the demise of such lending stimulated the more rapid creation and adoption of a sub-national system of credit that relies less on direct public sector involvement and that is more market-oriented. Of course, any new system of ďŹ nance would be confronted with some of the same problems as those that constrain on-lending, including the limited number of creditworthy borrowers, as well as other restrictions of a regulatory nature. Still, developing sub-national government access to private capital markets, supported by the creation and use of various credit enhancements, as has been done in other countries, would appear to represent a plausible way forward. It will take time to put relevant institutions and techniques in place: one would not expect this to be accomplished in less than several years time. A positive step in the right direction would be for government and aid agencies to embrace the anticipated change and work together to make the transition a successful one, rather than continue to tinker with reforms at the margin of a moribund system.

Lewis, B. D. On-Lending in Indonesia: Past Performance and Future Prospects. BIES, April 2007. The full report can be downloaded from www.dsďŹ ndonesia.org. The views expressed in this paper are solely those of its author(s).

On-Lending in Indonesia: Past Performance and Future Prospects


Policy Briefs

On-Lending in Indonesia: Past Performance and Future Prospects

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